Time To Dump UNG?

Related ETFs

Here are five scenarios that could happen now that the natural gas ETF is trading like a closed-end fund with a huge premium.

As markets keep distorting the valuation of the most direct way for most investors to tap into natural gas prices, does it make sense for investors to hang on for dear life?

Probably not. Under most short-term scenarios, holding onto the U.S. Natural Gas Fund (NYSE Arca: UNG) at this point is chock full of risk. At the same time, any potential upside seems to be totally tied to when—and if—the ETF opens to new investment and starts acting like its old self.

No matter what the charts say or deep-value-minded analysts might argue, holding UNG is no longer a question of picking among divergent investment philosophies. With the fund selling at a double-digit premium to its true net asset value, the chances of losing money in this ETF are significant.

Beyond Market Fundamentals

Let me make one thing perfectly clear: I’m not making a call on the natural gas market. We could be on the cusp of the greatest natural gas bull market of all time. But with UNG trading at a huge premium to its NAV and regulatory uncertainty swirling, this ETF isn't the best instrument for accessing that market right now.

As my colleagues Murray Coleman and Dave Nadig have noted (here and here), the developer of UNG has decided not to issue new shares of the ETF pending future regulatory action.

His concern is that regulators will place aggressive limits on the size of positions that commodity funds can hold. Specifically, he is worried that UNG is over this limit … or would be if more shares were issued … and he does not want to be forced to aggressively divest the fund’s position when and if new regulations come down.

The end result is that UNG is effectively trading as a closed-end fund, either unable or unwilling to issue new shares. At the close on Friday, it was trading at an 11.32% premium to its net asset value.

That makes me more than a little nervous.

Considering All Scenarios

Let’s think about how the situation with UNG might play out:

Scenario 1: No New Regulations, UNG Issues More Shares

The best-case scenario is that, after months of study, the regulators decide that ETFs are not to blame for increased volatility in the commodity markets and declare that no new position limits on commodities are necessary. If this happens, UNG will issue more shares and the premium will disappear. This will represent an 11% drag on investor returns.